Levered Free Cash Flow (LFCF): Definition, Calculation, Importance & Interpretation

Levered Free Cash Flow (LFCF) is a financial metric that measures the amount of cash a company has available after it has met its financial obligations, such as interest and debt payments. 

This cash flow figure is critical for investors and analysts because it provides a clearer picture of a company’s financial health and its ability to generate cash to pay dividends, reinvest in the business, or pay down debt.

The formula for calculating Levered Free Cash Flow is:

LFCF = Operating Cash Flow − Capital Expenditures − Debt Repayments

In this formula, 

• Operating Cash Flow (OCF) is the cash generated from the company’s core business operations.
• Capital Expenditures (CapEx) are the funds used by a company to acquire or upgrade physical assets such as property, industrial buildings, or equipment.
• Debt Repayments include both the interest and the principal payments made on the company’s debt.

LFCF is essential because it accounts for a company’s debt obligations, unlike unlevered free cash flow, which does not consider debt. By including interest payments and principal repayments, LFCF gives a more accurate representation of the cash available to equity shareholders. 

This metric helps investors understand whether a company can meet its financial commitments and still have cash left over for future growth and shareholder returns. It is a vital financial metric that provides valuable insights into a company’s cash flow after accounting for debt payments. 

Levered Free Cash Flow can be utilized in various strategic ways by a company. It can be directed towards paying dividends to shareholders, repurchasing shares, or reinvesting in business operations to drive future growth. These decisions reflect the company’s priorities and financial strategy.

A company can exhibit a negative Levered Free Cash Flow (LFCF) even if its operating cash flow remains positive. This situation often arises when a company undertakes significant capital expenditures or debt repayments that exceed its operating cash flow.

The level of Levered Free Cash Flow has significant implications for a company’s financial health:

High LFCF: Indicates more discretionary cash, greater capacity to take on debt, and lower credit risk. Companies with high LFCF are better positioned to invest in growth opportunities and weather economic downturns.

Low LFCF: Suggests less discretionary cash, reduced debt capacity, and higher credit risk. These companies may face challenges in meeting financial obligations and funding new investments.

A negative LFCF does not automatically signal a company’s failure. It may indicate substantial capital investments that have not yet yielded returns. As long as the company can secure the necessary funds to sustain operations until these investments start generating positive returns, a temporary period of negative LFCF can be manageable and strategic.

While negative LFCF can be a concern, it is not necessarily indicative of poor performance if the company is making strategic investments for future growth.

Levered Free Cash Flow (LFCF) refers to the amount of cash a business retains after meeting its debt and other financial obligations. It is calculated by subtracting debt repayments and interest expenses from the operating cash flow.

Unlevered Free Cash Flow (UFCF), on the other hand, is the cash available to a company before making any debt payments. The formula for UFCF is:

UFCF = EBITDA − CapEx − Working Capital − Taxes

LFCF is the cash flow available specifically to equity shareholders after all financial obligations have been met. It is a critical measure for investors as it provides insight into a company’s profitability and its ability to return cash to shareholders.

UFCF, however, represents the cash flow available to both shareholders and debt holders before any debt payments are made. This makes UFCF a broader measure that is useful for assessing the overall financial health of the company.

For LFCF, the discount rate used is the cost of equity (Ke), reflecting its relevance to equity shareholders. This metric is central to calculating equity value in a levered discounted cash flow (DCF) model, though this model is less commonly used outside of financial institutions where lending and interest income are core activities.

In contrast, UFCF employs the weighted average cost of capital (WACC) as its discount rate. This rate considers the cost of both debt and equity, making it suitable for calculating the enterprise value (TEV) in an unlevered DCF model. UFCF is neutral regarding capital structure, starting from net operating profit after taxes (NOPAT) and excluding debt repayments.

Investors often prioritize LFCF as it directly reflects the cash flow that equity shareholders can expect after all obligations are satisfied. This focus makes LFCF a better indicator of a company’s profitability from an equity perspective.

UFCF, meanwhile, is essential for understanding the total cash flow generated by the company that can be distributed among all capital providers. This comprehensive view is valuable for evaluating the company’s ability to meet its financial commitments and invest in future growth.

InvestingPro offers detailed insights into companies’ Levered Free Cash Flow including sector benchmarks and competitor analysis.

LFCF is crucial as it shows the actual cash available to shareholders after the company has met its debt obligations, providing insight into the company’s financial stability and flexibility.

LFCF includes the impact of debt payments, whereas Unlevered Free Cash Flow does not. This makes LFCF a more conservative measure, reflecting the company’s ability to generate cash flow after fulfilling its debt commitments.

Companies can use LFCF for various purposes, including paying dividends, repurchasing shares, investing in new projects, or reducing existing debt.

A negative LFCF suggests that a company does not generate enough cash to cover its debt obligations and capital expenditures, which may indicate potential financial distress or heavy investment in growth.

Yes, LFCF can vary greatly between industries due to differences in capital structure, debt levels, and capital expenditure requirements. It’s important to compare LFCF within the same industry for a meaningful analysis.